In today’s competitive environment, some bank directors may view an acquisition offer from another financial institution as a relief. With directors facing questions of how to gain scale in the face of heightened regulatory scrutiny, increased investor expectations, and general concerns about the future prospects of community banks, a bona fide offer to purchase the bank can change even the most entrenched positions around the board table.

So, how should directors evaluate an offer to sell the bank? A good starting place is to consider the institution’s strategic plan to identify the most meaningful aspects of the offer to the bank’s shareholders. The board can also use the strategic plan to provide a baseline for the institution’s future prospects on an independent basis. With the help of a financial advisor, the board can evaluate the institution’s projected performance should it remain independent and determine what premium to shareholders the purchase offer presents. Not all offers present either the premium or liquidity sought by shareholders, and the board may conclude that continued independent operation will present better opportunities to shareholders.

Once the board has a framework for evaluating the offer, it should consider the financial aspects of the offer. The form of the merger consideration—be it all stock, all cash, or a mix of stock and cash—can dictate the level of due diligence into the business of the buyer that should be conducted by the selling institution.

If the proposed offer consists of primarily cash consideration, the selling institution’s board should focus on the buyer’s ability to fund the transaction at closing. Review of the buyer’s liquidity and capital levels can signal whether regulators may require the buyer to raise additional capital to complete the transaction. Sellers bear considerable risk once a merger agreement is signed and the proposed transaction becomes public. The seller’s customers often think of the announcement as a done deal and the merger also naturally shifts the seller’s attention to integration rather than its business plan, which can benefit the combined company, but affect the seller’s independent results. It is difficult for the seller to mitigate these risks in negotiations, so factoring them into the board’s valuation of a sale offer is the best approach.

When considering a transaction in which a significant portion of the merger consideration is the buyer’s stock, the board has additional diligence responsibilities. First, the board should consider whether the buyer’s stock is publicly traded on a significant exchange or lightly traded on a lesser exchange. As the liquidity of the buyer’s stock decreases, the burden on the seller to understand the buyer’s business and future plans increase, as its shareholders will be “investing” in the combined company, perhaps for a lengthy period of time. The board should also consider if and when there will be opportunities for future shareholder liquidity.

On the other hand, when the seller’s shareholders are receiving an easily-traded stock, both parties will have an interest in mitigating the effects of market fluctuations on the pricing of the transaction. In most cases, a pricing collar, fixing the minimum and maximum amounts of shares to be issued, can allocate market risk between the parties. Such a structure can ensure that a market fluctuation does not cause the seller to lose its premium on sale or make the transaction so costly that it could affect the prospects of the buyer.

In addition to the financial terms of the proposed transaction, the seller’s organizational documents may include language allowing the board to consider a broad range of non-financial matters as part of the evaluation of a proposal. Certain matters, particularly with respect to how the seller’s executives and employees are integrated into the resulting institution and how the buyer’s business plan fits into the seller’s market, can have a significant impact on the success of the transaction. Just as community banking is largely a relationship-based model, the most successful mergers are those that make not only economic sense, but also address the “human element” to maintain key employee and customer relationships. The board can add value by raising these issues with management as part of its discussion of the merger proposal and definitive agreement.

In evaluating an offer to sell, the board is responsible for determining whether the bank’s financial advisors and management have considered a range of relevant items in evaluating an offer, including the offer’s financial terms, execution risks associated with the buyer, and social issues relating to the integration of the transaction. Using the bank’s strategic plan to determine which issues require closer scrutiny can focus the board’s attention on truly meaningful issues that will provide additional value to the institution’s shareholders.

This article was first published on BankDirector.com.